Tuesday, February 9, 2010

A Morphology of the Sin of Bad Lending

Grace – it is said – refers to a Single State only – whereas Sin refers to a multitude. Good Lending – like a State of Grace – is hard to maintain – but easy (and dull) to analyze if maintained. But – at the moment – I am studying US regional banks who are – to extend the analogy – no longer in a State of Grace.

Bad Lending however – like Sin – comes in many forms. There were bad mortgage loans with nothing down, no proof of income, no proof of assets and brokers incented to fraud. And there were milder Sins (with much lower loss rates). With commercial lending there were also a multitude of Sins – from lending to real-estate subdivisions in the desert (in towns with no market for the end product) to a commercial loan to a auto-mechanic to own their property. The desert housing development loans will probably default and average severity on such loans is above sixty percent. The auto-mechanic is probably underwater on the loan – but may have a personal guarantee and will not default even if they went delinquent as the economy soured.

Most bloggers are righteous people – and they bang-on about the fall from Grace. Get over it – we are not Virgins any more. What I am trying to compile – and I want my readers to help – is a Morphology of the Sin of bad commercial real estate lending. So I am begging for comment: I would like feedback on the state of debauchery in various markets. Some things I am observing are surprising me. Desert state vacant housing lot loans are – unsurprisingly – still a bust. But much to my surprise some Midwest banks have reported that they can now sell (for non-trivial money) vacant housing land from their real-estate-owned inventory. In that lies some redemption.

So consider this a request for recent anecdotes – by region and by commercial real estate class. Like some good Minister I want to understand your Sin...

8 comments:

Hank Paulson the Criminal
said...

John,

Now that Fannie Mae and Freddie Mac can shove the bad loans back to the banks, would they become profitable much sooner than your projected time frame in 2012?

You mentioned that the political risk is what keeps you up at night, are you able to sleep better now knowing that it is getting harder for them to get rid of GSE's as each they are counting on them more than ever to lift the housing market up?

I think they already presented the solution. It's to restore then to financial viability and hate them hard and in public. You can't have housing market in a good shape with GSE's in this sorry position they are in now.

So what do we have? Politically they will hate them. We knew that.

Financially, they removed caps and nationalization/r-ship option also unwinding option is out.

On the plus side, they are allowed to return crap back to the bank (big break for them).

They are given time to heal. Per John Hempton, they should be in working order in 2013, but with return of bad paper, it's way earlier.

They can't say in public anything good about GSE's, and they keep mum. What does that mean?

We need time and nothing crazy from the govt to heal, we are getting that + other perks. Nobody is going to crazy stuff now, so lets see what ernings are this year. I think they 2 will be profitable this year, and will grow equity. The more they make and the more equity they have, the less they are at the whim of politicans. Once equity breaks govt sr pfds, we are bona fide in the money. There is certainly no reason to price $0 wipe out now for pfds.

John Hempton addressed 10% rate too, so hopefully he is right with his math, and I would take his work over CBO estimates that are basically average whole loan collateral price - current coup TBA price.

It's a stale mate situation for the govt with regards to GSE's, they can't do anything to disband them, except to curse them out in public.

With regards to the UK and Ireland, just where do we begin, some of my favorites

1) Lending agaisnt leashold property where the freeholder has forfiture on insolvency of the leaseholder provisions. The leaseholder gears up their assets, then purchases the freehold and declares the leasehold owning vehicle insolvent thereby generating a 100% loss for the bank, and a 100% windfall for themselves

2) One Scotish Bank and an Icelandic bank who didn't seem to understand the difference between a residual, used in a development, and an investment valuation

3) The Irish bank who was more than happy for their borrowers to put in their "equity" by way of a personal g'tee. Many of the guarentees were never actually signed and those that were are meaningless anyways.

4) The UK bank, of Scotish origin, what is it with the Scots, Irish and commercial property, who, thinking themselves to be very clever, carried out cash backed synthetic securitisatons. The only problem being that the cash had to be moved once the arranging bank was downgraded by the rating agencies

5) All those German Banks who took senior positions and didn't realise that the arranging bank, whose skin in the game was kept by a mez position, was effectivly the controlling creditor. Actually the Germans, on the whole, were pretty sober with regards to direct UK lending (not with regards to buying anything rated AAA)

6) The Irish building socirty who tried to copy Bank Of Scotlands integrated finacne model, only at lease Bank of Scotland got most of the development profits, whereas this building soc come opportunity fund, was more than happy for their borrower/JV partner to keep almost all of the upsdie. Indeed they were even happy for developers to take all their profits out on day 1 by effectivly selling the residual land to the bank

7) The clever bank who lent one well known invester a £945m loan, representing a 105% LTV (The 105% being the top of the market). The loan was a securitisation bridge for a year but the swap was, of course, for 30 years. The investor gets a 100bps management fee out ahead of senior interest. So not only did they get a day one dividend of £45m, they also get a £9m management fee. The bank can only stop this fee by enforcing, which would mean taking a bath on the swap. Ooops

8) All those banks who wrote, 30, 40 year swaps, on the basis that long dated swaps were a semi-property hedge - they did actually used to tell credit that. Of course booking tbhe PV of 30 years worth of 20-30bps in their P&L had nothing to do with it. Also the fact that at the top of the market this was the only way to get high senior leverage on a cash pay basis was just a coincidence.

If these busted markets are seeing any traction its no surprise that the bearded one is now talking about exit plans.

For this kind of data the likes of Real Capital Analytics or just your good ol' Cushman Wakefield / CBRE market data can't be that bad. There's been a hell of a lot of money raised for distressed debt funds that is probably under utilized given the LBO syndicate loan apocalypse ended in early-mid 09 from a pricing point of view.

This isn't real estate but I still get a laugh: Evergreen Solar lent Lehman 25 million shares (1/4 the company's value) in conjunction with a convertible debt offering. It lowered their borrowing cost by 1/2%. The bond holders promptly sold short the shares to lock in their risk free loan to Evergreen. The accountants didn't make Evergreen declare the shares as outstanding since they were loaned to Lehman. Lehman went bankrupt. Evergreen is not getting their shares back. Evergreen gave away 1/4th the company to lower their borrowing costs by 1/2%. Ooops.

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